How China's shifting tastes could reshape the Australian economy

The shifting tastes of China’s free-spending middle class, and their appetite for services, could reshape the Australian economy.

A conversation about sandwiches and burgers may seem mundane, but for Australian David Keir it delivered a light bulb moment.

“There I was, operating the Subway brand in Beijing, when I suddenly realised none of my long-term Chinese franchisees understood the difference between our products and those from KFC and McDonald’s,” says the University of Queensland graduate. “It showed me that in China, making basic assumptions can really trip you up.”

Ten years later, Keir is putting his cultural understanding into practice. Freedom Road Travel, his recently formed company with offices in Shanghai, Brisbane and Sydney, is a trailblazer as the first wholly Australian-owned travel firm in China.

Keir has timed his entry into China’s services market well. The Asian nation now has more than 225 million households classified as middle class and a huge economy still growing at almost 7 per cent annually. Services are the major growth areas, with cashed-up consumers seeking more comfort, convenience or, sometimes, adventure.

Between 2005 and 2015, Chinese service imports grew at an average annual rate of nearly 20 per cent – almost double the growth rate of imported goods. In 2015, for the first time, services accounted for more than half of Chinese GDP.

China presents new opportunities for Australia, which currently derives 70 per cent of GDP from services. The 2015 China-Australia Free Trade Agreement (ChAFTA) opened about 40 service areas and allows better access for Australian service providers compared to those from most other developed economies.

“Between 2005 and 2015, Chinese service imports grew at an average annual rate of nearly 20 per cent – almost double the growth rate of imported goods...”

One high-demand standout service is aged care. Listed companies, including Lend Lease and Aveo, are already running jointly held aged-care centres, capitalising on the retirement needs of older Chinese. In ageing, post-one-child China, caring for the rapidly increasing number of elderly parents is a new expense for the middle class.

Healthcare and medical providers are similarly being wooed with opportunities to establish wholly owned enterprises in many of China’s major cities. Financial service providers are also well placed to gain from the growth and liberalisation of services.

Yet ChAFTA’s full impact is expected to take time. “For Beijing, ChAFTA represents a toe in the water,” says Kristen Bondietti, principal trade consultant at ITS Global.

“The Chinese government clearly wants to generate more economic growth from services, but it is difficult to assess how quickly they can and want to open the market.”

Competition for services

Australia’s service exports to China have massive growth potential, but businesses banking on revenue from tourism, healthcare and education service exports equalling what was previously earned from Australia’s resources exports may be disappointed.

According to figures from a 2016 Goldman Sachs report, Australia’s net exports of tourism and education services – the country’s two main service export industries – rose by more than A$5 billion from the first quarter of 2014 until the middle of last year. Conversely, in 2015, annual earnings from bulk commodity exports fell by A$24 billion. The evolving Chinese market is the main force behind this dynamic.

Australian service providers are likely to face competition far stiffer than producers of iron ore and coal ever have. “There aren’t any Australian service companies dominating the market the way BHP Billiton and Rio Tinto do,” says Martin Foo, a research officer with the Australian Centre for Financial Studies (ACFS).

“Australian service providers will be up against companies from [other] advanced economies, such as those in North America and Europe, as well as Asian economies at various levels of development,” says Australian economist Saul Eslake.

“They certainly shouldn’t expect the kind of price increases that commodities producers were once able to extract from Chinese customers.”

Despite the likelihood of a drop in export revenue, a 2016 ACFS report predicts Australia’s evolving trade relationship with China could generate one million new jobs in the five key service sectors of health, education, tourism, finance and construction by 2026.

“The benefits from Australian trade with China will be more broadly distributed across the national economy,” says Foo.

“Services are labour intensive, which bodes well for Australian jobs.”

China the conduit

There is scope for Australian service providers to develop more widespread international business.

“Many Australian services businesses – such as those involved in education and aged care – are hoping the development of Chinese business will lead into other Asian markets,” says Bondietti.

President Xi Jinping’s ambitious One Belt, One Road initiative, which calls for the development of trade routes across Asia and beyond, could offer Australian service companies lucrative opportunities in third markets. China’s intensifying focus on Silk Road trade has already seen a number of Australian law firms profiting from opportunities in the African mining sector.

“Many of the areas covered by the One Belt, One Road initiative are now experiencing growth and early stage regional integration,” says Dr Lauren Johnston, a research fellow at the Melbourne Institute of Applied Economic and Social Research.

“If Australian companies can leverage opportunities, then Chinese growth could help to internationalise the Australian service industry.”

Meeting demand

In a competitive environment, the ability of Australian service providers to leverage burgeoning Chinese demand is far from certain. The challenges they face include a lack of Asia-literate staff, operating within an unfamiliar legal system, information security and intellectual property concerns, and the capacity to repatriate profits.

“Business location is very important,” says Michael Ball, institutional banking global head of healthcare and ageing at National Australia Bank. “China’s legal framework becomes harder to negotiate the further you go from first-tier cities.”

Compared to the past two decades of Australia remotely selling “rocks and crops”, service industries operate in far more personal ways, often relying on market customisation, linguistic skills and cultural awareness.

“It is absolutely critical for Australian companies servicing the Chinese market to appreciate that country’s unique cultural and linguistic norms,” says Keir. “Those companies which effectively localise tend to be the ones that succeed over the longer term.”

“Service cooperation between Australia and China is more about exporters honing their competitiveness rather than benefiting from any windfall,” says Professor Hans Hendrischke from the University of Sydney Business School (USBS), who is also chair of the Business and Economics Cluster at USBS’s China Studies Centre.

For better or worse, Australia is heavily dependent on the Chinese economy. For many ambitious, well-positioned Australian service providers, the opportunities are clear and present.

As this economy continues to shift to services, the big question is how many Australian firms can follow in Keir’s footsteps. “I don’t make China-based assumptions any more,” concludes Keir, “but right now, the future definitely looks good.”

Hidden services

China’s import of direct services from Australia only tells half the story. Direct service exports are complemented by indirect services, such as transport, storage and packaging, exported to China in the form of value-added services embedded in goods.

A 2016 report by the University of Sydney and Westpac shows that in 2015, the export of these value-added services to China amounted to approximately A$25.1 billion, compared to A$9.8 billion in direct services.

The baby boom

Yu Bijun slowly makes her way through crowds clogging the halls of Chongqing public hospital in China’s west. The 48-year-old first walked this route 17 years ago, seeking help to have a baby.

After three failed attempts at in vitro fertilisation (IVF) in Guangdong, Yu came to Chongqing in 1999 to receive treatment that was new to China at the time – the first IVF baby had only been born a decade earlier.

“I now have a 17-year-old son, Xi Guo Xian,” she says with pride. “He was among the first 100 IVF babies born in western China. I am so thankful to this place.”

About 10,000 patients go through IVF every year at Chongqing public hospital, at a cost of about 40,000 yuan (A$7750) for each cycle.

With the end of the one-child policy, about 90 million Chinese couples are eligible to have a second child, and roughly 60 per cent of these couples are aged 35 or older. That has consequences. According to the All-China Women’s Federation, 40-50 million Chinese women and 45 million men suffer from infertility.

There are currently about 400 IVF clinics across China. However, with biological clocks ticking, an increasing number of the nation’s middle class is heading overseas for IVF treatment. Some pay as much as US$30,000 per IVF cycle, says Hou Kun, founder and chairman of McKinsey International Health Care.

Hou’s Beijing-based firm is one of many that is banking on babies. For US$5000, McKinsey acts as a one-stop shop for Chinese going abroad for IVF, connecting them with clinics in the US and holding their hand every step of the way.

Hou says the factors luring Chinese patients to places such as the US, Russia, Malaysia and Thailand for IVF include immediate treatment as well as perceptions of quality, higher success rates among older patients, gender selection and the ability to use a surrogate or undergo treatment regardless of marital status.

“About 4000 Chinese people visit the US for IVF treatment annually and some of the US clinics Hou deals with now cater almost exclusively to Chinese patients.”

“These are professional, middle class people,” says Hou. “The first criterion is they must have money.”

About 4000 Chinese people visit the US for IVF treatment annually, Hou says, and some of the US clinics he deals with now cater almost exclusively to Chinese patients. These firms, as well as Hou’s, aren’t the only ones who see the potential.

In November 2016, China’s online travel giant Ctrip bought out ChiTech, a company widely regarded as the nation’s leading medical tourism provider.

Australia’s Monash IVF, which operates IVF clinics, ultrasound practices and service centres across Australia and Malaysia, is actively looking for a local partner in China.

Hou says everyone sees growth potential in meeting China’s demand for IVF which, along with plastic surgery, accounts for the lion’s share of the Chinese medical tourism market. According to a report from VISA and Oxford Economics, international medical tourism is currently valued at US$439 billion annually.

The report predicts that medical tourism will experience annual growth of 25 per cent over the next decade, with China tipped to become the biggest market in the world during that period.